What is a Stock Dip?
Throughout its history, the stock market has had periods of growth and decline. Invariably, any given security may drop drastically over a short period. Investing your money when a stock or index has a sharp decline is “buying the dip.” It may seem obvious in hindsight that the dip was a good opportunity to get in, but it’s challenging to time the market.
Investors looking to buy the dip will typically have some capital set aside, waiting for opportunities in the market. They may even have particular security that they have been monitoring but felt its price was too high to justify purchasing. However, if the company’s stock experiences a decline due to a broad market downturn while its fundamentals remain intact, an investor may view that as a good buying opportunity.
A good example of this type of market behavior was seen in March 2020, as the pandemic raged worldwide. In late February, the S&P 500 began to fall below 3000, eventually reaching a low of around 2,300 around March 20. Pundits thought that the market could stay at these levels or fall even more as the pandemic spread through the economy.
However, by late May of the same year, the index had recovered back above 3,000. At the time, no one could have reliably predicted a short-term dip followed by a recovery.
Do Stocks Dip Before Earnings?
Stocks may dip before, during, or after earnings releases. A stock could dip even if a company reports strong business developments and earnings. That is because some investors and analysts pay attention to expectations and estimates rather than the absolute numbers. For example, if consensus analyst estimates show that earnings will be $1.00 per share but end up being $0.90, there could be a dip in stock price, even though $0.90 might be a big improvement for the company. So positive news does not always lead to an increase in stock price.
The Efficient Market Hypothesis (EMH), a largely academic construct (although it does have real-world applications), states that because information is symmetrically available to all investors, the stock price of many companies will always be efficiently priced. EMH is a somewhat controversial topic, as many investors believe that price swings (and stock dips) result from market forces that can be largely irrational on a macro scale. Therefore, stock dips before earnings could result from a plethora of information being funneled through stock influencers such as investors and analysts.
Is Buying the Dip a Good Idea?
If a stock’s price recovers, buying the dip will always seem like a good strategy in hindsight. However, predicting how far a dip will go is often quite difficult and highly speculative. You may buy a security upon an initial dip, only for it to continue to slide further. Additionally, it is possible for that stock’s price to simply never recover to prior levels.
Long-term investors will generally decide on a company’s business strategy and price fundamentals. As such, you would expect short-term movements in a company’s stock price not to influence their decision-making. However, value investors are also always looking for “bargains” where the market may have irrationally beaten down the price of a particular security. If this occurs to a company with solid fundamentals, you may get a very good price for a company you plan to hold onto for the long term.
When Should You Buy the Dip?
Incorporating a stead-fast investment philosophy is a useful strategy for long-term investment, and it will get you through the tough times, including dips in stock prices. However, if you are just moving into a particular stock, buying the dip could be useful. When buying the dip, you are essentially deciding based on a lowered stock price and the expectation that the price will recover or rise given time. A good time to buy the dip might be when a stock drops due to widespread market fears instead of specific concerns about a company’s long-term health.
Why Does Dollar Cost Averaging Beat Buying the Dip?
Buying the dip takes a shrewd temperament and lots of patience. To buy the dip successfully, you must first get in when the stock price is at a low (which requires market-timing), and you must also wait for the price to go up. Some would argue that this strategy makes you miss out on other investment opportunities. Buying the dip does give you a certain sense of confidence since you did not buy at the “worst time” (i.e., when the stock was trading at an all-time high). Since stock trading can be scary, many people are starting to buy the dip to get into stock investing.
Dollar-cost averaging means allocating the same dollar amount to a given security monthly or quarterly, regardless of your price. You will invariably be taking advantage of dips through this method. Still, you don’t have to worry about timing because you systematically average the price you are getting periodically.
See important disclosures at masterworks.io/cd
This content is for informational purposes only and not intended to be investing advice.